Exactly what Krugman Gets Right plus Wrong on Trade Surpluses

Krugman’s recent NYT column on Russia functions commentary on trade surpluses that is at best very misleading

Longtime readers realize that I am  not the biggest fan   of Paul Krugman, especially when it comes to his advocacy of government inflation and spending budget deficits.

It’s especially ironic when I  criticize   Krugman’s  writing  on international trade, considering that that’s the area in which this individual won the Nobel Prize. But here we go again, as  Krugman’s recent  New York Periods   column upon Russia   functions commentary on trade surpluses that is at best very misleading.

Krugman on Russian Trade

The context for Krugman’s article could be the West’s trade sanctions on Russia in retaliation for that invasion of Ukraine. Since other countries are still importing Russian oil and gas but exports to Russia are efficiently discouraged, Russia now includes a large trade surplus. But even though many people (including supporters of Donald Trump) bring it for granted that industry surpluses are a good thing, Krugman argues to the contrary:

The effect associated with sanctions on Russia offers a graphic, if grisly, display of a point economists often try to make, but hardly ever manage to get across: Imports, not exports, are the point of international trade.

That is, the benefits of trade really should not measured by the jobs and incomes created in foreign trade industries; those workers can, after all, be doing another thing. The gains from trade come, instead, from the useful services and goods other countries provide to your citizens. And  running a trade surplus isn’t a “ win”; if anything, this means that you’re giving the world over you get, receiving nothing but i. o. u. s in exchange.

Yes, I know that in practice you will find caveats and complications to statements. Trade surpluses can sometimes help boost a weak economy, and while imports make a nation richer, they may shift and impoverish some employees. But what’s happening to Russia illustrates their essential truth. Russia’s trade surplus is a sign of weakness, not strength; its exports are (alas) holding up nicely despite its pariah position, but its economy is being crippled by a cutoff of imports. (bold added)

Although I understand the essential (and important) point Krugman is trying to make in the above excerpt, in his zeal in order to explode mercantilist fallacies,   Krugman swings too far in the opposite direction. Specifically, the particular sentence I put in vibrant is at best misleading, with worst simply wrong. (I should note that this has absolutely nothing to do with Keynesian ideology; elsewhere I caught the  Wall Street Journal   making a similar mistake. )

In the rest of this article, I’ll very first explain what Krugman gets right in the above comments, but then spell out what’s wrong with it too.

What Krugman Gets Right on Trade Surpluses

Krugman is right that in the grand structure, the benefits of international trade would be the goods and services that people in a provided country can obtain from foreign people at a lower cost than if they had to produce those goods and services locally.

The rule is obvious when it comes to an individual household: It would be foolish for that Smith family to “ buy local” by increasing their own food, making their own clothes, and building their very own cars. Instead, the Cruz family enjoys a much increased standard of living by focusing on individuals areas in which they excel— perhaps Mr. Smith is definitely an accountant, Mrs. Smith is really a lawyer, and the teenagers work at the mall— and making far more of these services than the Smith household will personally consume. The Smiths sell the excess services to people outside of their household in exchange for money, which they use to “ import” food, clothes, cars, and everything else they want.

A similar pattern holds in the country level. The United States likes a much higher standard of living, for each capita, by focusing on generating those goods and services in which the people have a “ comparative advantage. ” Those products made in excess of  exactly what Americans consume domestically could be exported abroad  and utilized to buy imports from other countries. This allows the US and her investing partners to consume more (again, per capita) than if each country relied just on items made locally.

Furthermore, in the excerpt above, Krugman is right that we shouldn’t focus on the jobs that are “ created” in export industries. As long as wages and prices are allowed to adjust, in the long run every productive worker can ultimately find a job and make a living, whether the worker serves the particular domestic or international marketplace. That’s why  if we would be to blockade a country and cut it off from the rest of the world, the harm we would impose would be due to reducing off imports flowing in to the country. The workers who also originally (before the blockade) were in the export field could eventually find work producing goods and services for their neighbours. It’s just that they would be earning far lower real income in the new setting,   because they would be missing out on the benefits of the international division associated with labor.

Where Krugman Goes Wrong on Trade Surpluses

As We have argued above, the basic gist of Krugman’s analysis is correct. However , he oversteps by possibly misleading the average reader when he writes: “ Running a trade surplus isn’t a ‘ win’; if anything, it means that you’re providing the world more than you get, receiving nothing but i. o. u. s in return. ”

To repeat what I said above, this dubious way of writing isn’t restricted to Keynesians; the free-market publishers at the  Wall Street Journal   made this mistake   even more explicitly when writing the subtitle to a Robert Barro op-ed. In order to see the problem, we can once again go back to a household analogy.

Suppose Mr. Smith requests his two teenagers  exactly how their finances are faring. His daughter reports that over the year she gained $10, 000 working in a clothing store in the shopping mall and spent $7, 1000 on her car, clothing, going to the movies, and other fun products. She put the remaining $3, 000 into a savings account with her local bank.   Mr. Smith’s teenage kid reports that he earned 10 dollars, 000, too, from promoting pretzels at the mall. However , the son spent a total of $12, 000 upon fun items during the year, depleting all of his earnings along with running up $2, 000 in credit card debt.

How should Mr. Smith react to these reports? He may be tempted to compliment the daughter, but getting just read Krugman’s column on Putin, Mr. Cruz instead scolds her. “ Julia, don’t think you are ‘ winning’ just because you sold more than you purchased, ” he or she complains.   “ When anything, your report implies that you’re giving the community a lot more (in retail services) than you get, receiving nothing but a good IOU from the bank in exchange. ”

In comparison, Smith congratulates his clever son, who managed to persuade the community to give him $12, 000 worth of goodies  in exchange for only 10 dollars, 000 in pretzel-preparation services. Suckers!

Trade Deficits  Can  Be Productive, As well

In the previous section, I used a simple analogy of a household to showcase how Krugman’s Putin column could possibly mislead readers. Specifically, a trade debt doesn’t mean that a country is driving a hard discount with foreigners and getting a lot more imports in exchange for its exports. No, when we measure imports and exports in this framework, we are already using money terms. So if the US imports (say) $50 billion in goods from Japan throughout a certain period, it pays precisely $50 billion for them— that’s what it means to measure in dollar terms.

Before closing this article, I want to avoid giving the reader the wrong impression going the  other  method. Even though in my Smith home analogy above, it was apparent that the teenage son had been engaged in behavior that was not sustainable in the long run, that doesn’t mean that trade deficits are a bad thing or necessarily unsuccessful.

For example , imagine a small country’s inhabitants view the light and all become Rothbardians. Their government adopts incredible policies such as slashing fees and regulations (or maybe even dissolves away entirely, allowing for  private legal courts and military defense ). The revamped country would certainly enjoy tremendous economic development as a consequence.

In this particular scenario, the rest of the world would certainly invest more  (on net) in this new Rothbardia compared to its residents would purchase the rest of the world. This would appear in the official statistics as being a trade deficit for Rothbardia. Intuitively, the rest of the world would certainly send real resources (such as oil, natural gas, steel, etc . ) to the little country in exchange for part ownership of the new prosperity being created in the laissez-faire powerhouse. (For more details on trade accounting, see  my earlier article . )

Conclusion

Professional economists have been attempting for centuries to get the public to understand that when it comes to international business, the benefits flow from the capability to  import  goods and services on better conditions than they could be produced on domestically. The jobs plus incomes in export industrial sectors are incidental,   due to the fact workers  could find jobs creating for their neighbors if the export sector didn’t exist (after wages and prices adjust).

However , in their zeal to drive home the relative benignity of business deficits, economists sometimes overshoot and end up leading visitors to believe that trade  surpluses  are poor.   But this is wrong. In general, so long as they are the consequence of voluntary decisions, trade surpluses make a country richer compared to would otherwise be the case. There’s nothing foolish about piling up IOUs in exchange for excess exports, just as there’s nothing silly about a household living beneath its means and gathering financial assets.

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